Near the Corner of Church and State

Is Corporate America's cozy relationship with Wall Street's sell-side analysts about to come to an end?

Possibly. As CFO.com reported in late April, New York State attorney general Eliot Spitzer's investigation into conflicts of interest at Merrill Lynch is apparently wrapping up. Reportedly, management at the investment bank is close to agreeing on a settlement with Spitzer. Part of the deal: reportedly, Merrill will pay New York State a hefty fine for its actions.

And on Wednesday, the Securities and Exchange Commission approved new rules aimed at addressing conflicts of interest that arise when research analysts recommend the securities of their firm's customers.

The new rules include the following provisions:

Prohibit analysts from offering or threatening to withhold a favorable research rating or specific price target to induce investment-banking business from companies. The rule changes also impose "quiet periods" on an investment bank that is acting as manager or co-manager of a securities offering. Under that provision, the firm will be prohibited from issuing a report on a company within 40 days after an initial public offering, or within 10 days after a secondary offering for an inactively traded company.

Prohibit analysts from being supervised by managers in the investment-banking department. In addition, investment-banking personnel will be prohibited from discussing research reports with analysts prior to distribution.

Require a securities firm to disclose in a research report if it managed or co-managed a public offering of equity securities for the company, or if it received any compensation for investment-banking services from the company in the past 12 months.

Bar analysts and members of their households from investing in a company's securities prior to an IPO if the company is in the business sector that the analysts cover. In addition, the rule changes will require "blackout periods" that prohibit analysts from trading securities of the companies they follow for 30 days before—and 5 days after—they issue a research report about the company.

Require analysts to disclose if they own shares of recommended companies.

Require firms to clearly explain in research reports the meaning of all ratings terms they use, and this terminology must be consistent with its plain meaning.

Analysts making public appearances, such as television or radio interviews, must disclose if they or their firm have a position in the stock and also if the company is an investment-banking client of the firm.

Meanwhile, back on the Street: while Merrill Lynch appears to be nearing a settlement with New York state, the bank still faces a lawsuit arising from Spitzer's investigation. It seems some investors are less than thrilled that Merrill analysts allegedly issued buy ratings on certain company stocks—while privately deriding those companies. In addition, it's uncertain whether Spitzer's investigation will end with Merrill Lynch or spread to the rest of the investment-banking community. Even with the SEC's announcement on Wednesday, this controversy is a long way from over.